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COMPENSATION (a) While payment must be complete and indivisible

as a rule,
Art. 1278. Compensation shall take place when in compensation, partial extinguishment is always
two persons, permitted.
in their own right, are creditors and debtors of (See 8 Georgi, Teoria de las Obligaciones, pp. 24-
each 25).
other.
(b) While payment involves action or delivery, true
(1) ‘Compensation’ Defi ned compensation
(legal compensation) takes place by operation of law.
(a) “It is a sort of balancing (cum ponder — ‘to
weigh together’) (4) ‘Compensation’ Distinguished from ‘Merger’
between two obligations; it involves a fi gurative
operation (a) As to the number of persons:
of weighing two obligations simultaneously in order
to In confusion, there is only one person in whom is
extinguish them to the extent in which the amount of merged the qualities of creditor and debtor.
one In compensation, there must be two persons who are
is covered by the other.” (8 Manresa 366). mutually creditor and debtor to each other.

(b) It is the extinguishment in the concurrent amount (b) As to the number of obligations:
of the In confusion, there can be only one.
obligations of those persons who are reciprocally In compensation, there must be two.
debtors
and creditors of each other. (Castan, Derecho, Civil (6) Kinds or Classes of Compensation
Español,
p. 61). (a) According to its effect or extent:
(1) Total — if both obligations are completely
(2) Usefulness of Compensation extinguished
because they are of the same or equal
In effect, it is a specie of abbreviated payment which amounts.
gives (2) Partial — when a balance remains (hence, there
to each of the parties a double advantage: is a
partial compensation in the larger of the two debts).
(a) “facility of payment;
(b) According to its origin or cause:
(b) guaranty for the effectiveness of the credit 1) Legal — this takes place by operation of law, and
because if one need
of the parties pays even without waiting to be paid by not be pleaded.
the 2) Voluntary or conventional — this is due to the
other, he could easily be made a victim of fraud or agreement
insolvency.’’ of the parties.
(Castan, Derecho, Civil Español, pp. 61-62).
3) Judicial (also termed “set-off”) — this must be
Indeed, it is simplifi ed or abbreviated payment, pleaded;
because it can be made effective only by an order from the
the two debts are extinguished without requiring the court. (See Yap v. Chua Jamco, 14 Phil. 602; See
transfer of money or property from one party to the also
other. Art. 1283, Civil Code).
(TS, May 11, 1926).
4) Facultative — here, one of the parties has the
(NOTE: In banking operations, a “clearing house” choice of
takes care of compensation in banking accounts.) claiming the compensation or of opposing it (perhaps
because not all the requisites of legal compensation
(3) ‘Compensation’ Distinguished from ‘Payment’ are present).
(7) When Compensation Cannot Exist (a) Over neither of the debts must there be any
Under the law, the two persons concerned are retention or controversy
creditors and commenced by third persons and communicated
debtors of each other; therefore, a debtor of a in due time to the debtor. (Par. 5, Art. 1279). Thus,
corporation cannot there
compensate his debt with his share of stock in the can be no legal compensation when one’s claim
corporation, against
since the corporation is not considered his debtor. another is still the subject of court litigation. (Miailhe
(Garcia v. v.
Lim Chu Sing, 59 Phil. 562). It would have been Halili, L-16587, Oct. 31, 1962).
different had
the corporation really been his debtor as when he had (b) There must have been no waiver of the
paid it a compensation (such
sum greater than the value of his shares. (Brimo v. waiver could have been validly agreed on, since this
Goldenberg would
and Co., Inc., 40 O.G. [6th S] No. 10, p. 199). not be contrary to public policy). (Manresa).

Art. 1279. In order that compensation may be (c) The compensation of the debts must not have been
proper, it prohibited
is necessary: by law. The compensation of the following are
(1) That each one of the obligors be bound prohibited:
principally,
and that he be at the same time a principal 1) debts arising from a depositum (except bank
creditor of the deposits,
other; which are by law considered as loans to the bank)
(2) That both debts consist in a sum of money, or (Art.
if the 1287; Art. 1980, Civil Code);
things due are consumable, they be of the same 2) debts arising from the obligations of a depository
kind, and also (Art.
of the same quality if the latter has been stated; 1287, Civil Code);
(3) That the two debts be due; 3) debts arising from the obligations of a bailee in
(4) That they be liquidated and demandable; commodatum
(5) That over neither of them there be any (like the borrower of a bicycle) (Art. 1287,
retention or Civil Code);
controversy, commenced by third persons and 4) debts arising from a claim for future support due
communicated by
in due time to the debtor. gratuitous title (Art. 1287, Civil Code);
5) debts consisting in civil liability arising from a
(1) Legal Compensation or Compensation by penal
Operation of offense (Art. 1288, Civil Code);
Law
6) damages suffered by a partnership thru the fault of
The requisites enumerated under Art. 1279 are those a partner cannot be compensated with profi ts and
for LEGAL compensation; voluntary compensation benefi ts which he may have earned for the
in general partnership
requires no requisite except that the agreement be by his industry. (Art. 1794, Civil Code). Reasons:
voluntarily Since the partner has the duty to obtain benefi ts for
and validly entered into. the fi rm, and a duty not to be at fault, there can be no
compensation because both are duties, and the part-
(2) Affi rmative Requisites for Legal ner is the debtor in both instances. (See 11 Manresa
Compensation
Items (1), (2), (3) and (4) of Art. 1279 are the affi 377).
rmative [NOTE: The courts may, however, equitably
requisites. lessen this responsibility of the partner, if, thru the
partner’s extraordinary efforts in other activities of
(3) Negative Requisites for Legal Compensation the partnership, unusual profi ts have been realized.
(Art. 1794, Civil Code).] (b) Example:
A owes B a fountain pen (generic). B owes A also a
(4) The First Affi rmative Requisite fountain pen (generic). There can be compensation
“That each of the obligors be bound principally, and here
that because the objects are fungible (although not
he be at the same time a principal creditor of the consumable).
other.”
[NOTE: Had specifi c fountain pens been agreed
(a) Firstly, there must be a relationship of debtor and upon,
creditor. there can be no compensation (legal compensation).]
(b) Secondly, there must be two debts and two credits.
(c) Thirdly, they must generally be bound as [NOTE: Ten sacks of corn cannot be compensation
principals (and (legal compensation) for ten sacks of rice.]
not in their representative capacity).
(6) The Third Affi rmative Requisite
Example:
G, as guardian for W, is a creditor of D. D in turn is a “That the two debts be due.”
creditor of G who owes him a personal debt. There
can be (a) “Due” means that the period has arrived, or the
NO compensation because it is W who is the real condition
creditor, has been fulfi lled. On the other hand, “demandable”
not G. may
refer to the fact that neither of the debts has
Another example: prescribed,
A, debtor of two partners, cannot compensate the or that the obligation is not invalid or illegal.
debt
with what the partnership itself owes her. (Escano v. (b) Solita owes Edmundo P1 million payable Apr. 1,
Heirs 2005.
of Escano, 28 Phil. 73). Edmundo owes Solita P1 million payable Jun. 8,
2005. Can
Another example: there be legal compensation on Apr. 1, 2005?
A debtor owes a creditor P1 million but the creditor ANS.: No, for one of the debts is not yet due.
owes the debtor’s guarantor P1 million. The debtor However,
cannot there can be voluntary compensation upon
claim compensation. (HOWEVER, a guarantor may agreement. (See
set Art. 1282, Civil Code).
up compensation as regards what the creditor may
owe (7) The Fourth Affi rmative Requisite
the principal debtor. The reason is simple: If the
principal “That they be liquidated and demandable.”
obligation is extinguished, the accessory obligation of
guaranty (a) For the meaning of “demandable,” see comment
is also extinguished.) (See Art. 1280, Civil Code). No. 6(a).
Art. 1279
(b) If one of the debts has already prescribed, there
(5) The Second Affi rmative Requisite can be no
compensation (8 Manresa 411) for the simple reason
“That both debts consist in a sum of money, or if the that
things said debt is no longer demandable.
due are consumable (fungible), they be of the same Art. 1279
kind, and
also of the same quality if the latter has been stated.” (c) “Liquidated” debts are those where the exact
amount has
(a) The word “consumable” must be taken to mean already been determined, though not necessarily in fi
“fungible” gures
(susceptible of substitution, if such be the intention).
since capacity of being arrived at by simple (2) Examples
arithmetical
processes would be enough. If damages are asked for, (a) A owes B P500,000. C is the guarantor of A. B
and owes A
the amount is disputed, the debt cannot be said to be P100,000. When B sues A and A cannot pay, for how
already much
a “liquidated” one. (Compania General de Tabacos will C be liable?
v. French and Unson, 39 Phil. 34). Once liquidated ANS.: C will be liable for only P400,000, because he
by a can
judgment, however, a set-off asked for in a set up the P100,000 credit of A as the basis for partial
counterclaim compensation.
would be proper. (8 Manresa 409-410).
(b) A owes B P500,000. C is the guarantor of A. B
(8) The First Negative Requisite owes C
“That over neither of the debts must there be any P500,000. When B sues A for the P500,000, may A
retention successfully put up the defense of compensation in
or controversy commenced by third persons and that, after all,
communicated his creditor (B) owes C the same amount?
in due time to the debtor.”
ANS.: There can be no compensation here because
Example: in the obligation which C guaranteed for A, he (C) is
A owes B P100,000, and B owes A P100,000, but A’s not
credit bound in his own right. Neither is A the creditor of B.
of P100,000 has been garnished by C who claims to
be an unpaid (NOTE: If A cannot pay and B sues the guaranty, C
creditor of A. B has been duly notifi ed of the will not be liable anymore because the obligation of
controversy. There guaranty
can be NO compensation here. (See Rule 57, Sec. 8, has been extinguished by compensation.)
Revised
Rules of Court on Garnishment). Any possible Art. 1281. Compensation may be total or partial.
compensation is When the
in the meantime suspended. If C wins his claim, there two debts are of the same amount, there is a total
can be compensation.
no compensation; if he loses, the controversy is
resolved, and Total or Partial Compensation
compensation can take place. (8 Manresa 407). The Article is true for all the different kinds of
compensation,
Art. 1280. Notwithstanding the provisions of the whether voluntary, legal, etc.
preceding
article, the guarantor may set up compensation as Art. 1282. The parties may agree upon the
regards compensation
what the creditor may owe the principal debtor. of debts which are not yet due.

(1) Guarantor May Set Up Compensation With Conventional or Voluntary Compensation


Respect to (a) This applies to conventional or voluntary
Principal Debt compensation.
(b) As a matter of fact, the requisites mentioned in
(a) This is an exception to Art. 1279, par. 1, because a Art. 1279
guarantor do not apply.
is SUBSIDIARILY, not principally, bound. (c) It is suffi cient in conventional compensation that
the agreement
(b) Reason for the law: Extinguishment (partial or or contract which declares the compensation should
total) of itself be valid; thus among other things, the parties
principal obligation extinguishes (partially or totally) must
the
guaranty (which is merely an accessory obligation).
have legal capacity and must freely give their separately owed by, or due to, different parties, in
consent. which
case each separate claim furnishes the jurisdictional
Art. 1283. If one of the parties to a suit over an test.
obligation (Argonza, et al. v. International Colleges, L-3884,
has a claim for damages against the other, the Nov. 29,
former may set 1951 and Soriano y Cia v. San Jose, 47 O.G. 12th
it off by proving his right to said damages and the Supp.,
amount p. 156).
thereof.
(b) Where not all the causes of action joined are
(1) Judicial Compensation or Set-off demands or
claims for money. (Felix Vda. de Rosario v. Justice
(a) This refers to judicial compensation or set-off. of the
Pleading Peace of Camiling, et al., L-9284, Jul. 31, 1956, 52
and proof of the counterclaim must be made. O.G.
(b) All the requisites mentioned in Art. 1279 must be No. 5152).
present,
except that at the time of pleading, the claim need not [NOTE: Consequential damages and attorney’s fees,
yet when properly claimed and recoverable as an item of
be liquidated. The liquidation (or fi xing of the proper Art. 1283 damage, are not excluded from the
sum) jurisdictional amount.
must be made in the proceedings. (Suanes v. Almeda-Lopez, 73 Phil. 573).]
(c) Unless pleading and proof are made, the court
cannot of Art. 1284. When one or both debts are rescissible
its own accord declare the compensation. This is or voidable,
because of they may be compensated against each other
“the supplicatory character of our civil procedure.” before they
(Reyes & are judicially rescinded or avoided.
Puno, Outline of Civil Law, Vol. IV, p. 156, citing
Castan, (1) Compensation in the Case of Rescissible or
De Buen). The compensation takes place by the Voidable
judgment, Debts
as to the date the compensation was pleaded. (Reyes
& Rescissible or voidable debts are valid until rescinded
Puno, id.). or
voided; hence, compensation is allowed.
(2) Jurisdiction of the Court Regarding the Value
of the (2) Prevention of Unfairness
Demand To avoid unfairness if rescission or annulment is
General Rule: The jurisdiction of the court depends later on
upon decreed by the court, it is as if NO compensation ever
the totality of the demand in all the causes of action, took place.
irrespective The decree thus acts retroactively.
of whether the plural cases arose out of the same or
different Example:
transactions. (Soriano v. Omilia, 51 O.G. No. 7, p. A owes B P1 million. Later, A forced B to sign a
3465 and promissory
Campos Rueda Corporation v. Sta. Cruz Timber Co., note for P1 million in A’s favor. The fi rst debt is
52 O.G. valid; the
No. 3, p. 1387). second is voidable. But if all the requisites for legal
compensation
Exceptions: are present, both debts are extinguished since B’s
(a) Where the claim joined under the same complaint debt is
are not yet annulled. This is obviously unfair if, later on,
B’s debt
is annulled by the court. Thus here, the compensation place) was made WITH THE CONSENT of the
that has debtor. Such
taken place will be cancelled. consent operates as a WAIVER of the rights to
compensation.
Art. 1285. The debtor who has consented to the
assignment The exception to the exception occurs when “at the
of rights made by a creditor in favor of a third time he
person, gave his consent, he RESERVED his right to the
cannot set up against the assignee the compensation.”
compensation which (See 8 Manresa, pp. 413-414).
would pertain to him against the assignor, unless
the assignor (2) The Three Cases Covered by the Article
was notifi ed by the debtor at the time he gave his
consent, (a) The assignment may be made with the consent of
that he reserved his right to the compensation. the
debtor. (Par. 1, Art. 1285).
If the creditor communicated the cession to him (b) The assignment may be made with the knowledge
but but
the debtor did not consent thereto, the latter may without the consent (or against the will) of the debtor.
set up the (Par.
compensation of debts previous to the cession, but 2, Art. 1285).
not of (c) The assignment may be made without the
subsequent ones. knowledge of
the debtor. (Par. 3, Art. 1285).
If the assignment is made without the knowledge
of the (3) The First Case — The Assignment may be
debtor, he may set up the compensation of all Made With the
credits prior Consent of the Debtor [See also Comment No. (1)
to the same and also later ones until he had under
knowledge of the this Article]
assignment.
Effect: Compensation cannot be set up (because there
(1) Effect of Assignment on Compensation of has
Debts been consent and, therefore, a waiver).

Under Art. 1290, “when all the requisites mentioned Exception: If the right to the compensation (that has
in already
Art. 1279 are present, compensation takes effect by taken place) is reserved.
operation of
law, and extinguishes both debts to the concurrent Example:
amount, even A owes B P1,000,000. B in turn owes A P200,000.
though the creditors and debtors are not aware of the Because
compensation.” both debts are already due, and because all other
Thus, compensation takes place automatically or ipso requisites for
jure. Now then, if AFTER compensation has taken legal compensation are present, both debts are
place one of extinguished
the extinguished debts is ASSIGNED to a stranger, automatically up to the amount of P200,000. Later
ordinarily however, B,
this would be a useless act since there is nothing with the consent of A, assigned his (B’s) P1,000,000
more to assign. credit to C.
The defense of compensation could then be set up. How much can C collect successfully from A?

There is ONE exception to said rule, and this takes ANS.: C can collect from A the whole P1,000,000. A
place cannot
when the assignment (after compensation has already set up the defense of compensation as of the
taken P200,000 in view
of his consent to the assignment. not before. It does not matter that the P200,000 had
been
(NOTE: Had A reserved his right to the incurred prior to the cession, for when the law speaks
compensation, A of
would be forced to give only P800,000.) “debts previous to the cession,” it refers to debts
maturing
[NOTE: Par. 1 of Art. 1285 applies whether the before the cession (not to debts incurred prior to such
consent to cession
the cession was BEFORE or AFTER the debts which have not yet matured before said cession).
became compensable.
(8 Manresa 413-414).] (5) The Third Case — Assignment Made Without
the Knowledge
(4) The Second Case — Assignment Made With of the Debtor
the Knowledge
but Without the Consent or Against the Will of Effect: Debtor can set up compensation as a defense
the for
Debtor. all debts maturing PRIOR to his knowledge of the
Effect: Compensation can be set up regarding debts assignment
previous (whether the debts matured before or after the
to the cession or assignment. This refers to debts assignment).
maturing
before the assignment (that is, before the NOTICE); (NOTE: The crucial time here is the time of
hence here, knowledge of
legal compensation has already taken place. the assignment, not the time of assignment itself.)

Examples: Example:
(a) A owes B P1,000,000. B owes A P200,000. Both A owes B P1,000,000. B owes A in turn P200,000.
debts are Both
already due. Later B, with the knowledge but without debts are already due. Later, B assigns the
the P1,000,000 credit to
consent (or against the will) of A, assigned the C, without the knowledge of A. This assignment was
P1,000,000 made on
credit to C. How much can C successfully collect July 1. On Jul. 15, a P250,000 debt of B in favor of A
from A? matured.
A learned of the assignment on Aug. 1. On Aug. 23, a
ANS.: If A sets up the defense of partial P150,000
compensation as debt of B in favor of A matured. Later C asks A to
to previously maturing debts, C can collect only pay his debt.
P800,000. How much can C successfully collect from A?
There had already been compensation with respect to
the ANS.: C can collect P550,000 because A can set up
P200,000. the defense
of partial compensation regarding the P200,000 and
(b) A owes B P1,000,000 due on Apr. 2; B owes A the
P200,000 P250,000 debts, debts which had matured and were
due also on Apr. 2. On Feb. 4 (when there was no therefore
legal already compensable PRIOR to his knowledge of the
compensation yet), B assigned his P1,000,000 credit assignment.
to C, But A cannot set up the last debt of P150,000 for
with the knowledge but without the consent of A. On partial
Apr. compensation because this matured only after he
2, how much can C successfully collect from A? knew of the
assignment.
ANS.: P1,000,000, because if at all there would be
compensation here, it took place after the assignment, (6) Reason for the Article
Art. 1285 has for its purpose the prevention of cannot take place, such as:
fraudulent
deprivation of the benefi ts of total and partial (a) When one debt arises from a depositum (not bank
compensation. (8 deposit,
Manresa 413-414). for this is really a loan). (Gullas v. Phil. Nat. Bank,
62 Phil.
Art. 1286. Compensation takes place by operation 519 and Art. 1980, Civil Code).
of law, (NOTE: The purpose is to prevent breach of trust and
even though the debts may be payable at different confi dence.)
places, (NOTE: It is the depositary who cannot claim
but there shall be an indemnity for expenses of compensation.
exchange or The depositor is allowed to so claim.)
transportation to the place of payment.
(b) When one debt arises from the obligations of a
(1) Compensation by Operation of Law depositary.
(a) This applies to compensation by operation of law. (NOTE: This has the same reason as the preceding
(b) “Indemnity for expenses of transportation” (this one. Again, the depositor is given the right to claim
applies to compensation.)
transportation of the goods or of the object).
(c) “Indemnity for expenses of exchange” (this refers (c) When one debt arises from the obligations of a
to monetary bailee in
exchange, in case the debts are money debts). commodatum (the borrower of property who pays
nothing
(2) Example for the loan).
A owes B P1M payable in Manila and B owes A P1M (NOTE: Again, the reason here is to prevent a breach
payable of trust.)
in England. Whoever claims compensation must pay (NOTE: The lender may claim compensation; the
for borrower is NOT allowed to do so.)
the exchange rate of currency. [NOTE: In the three instances given above, since the
depositor and the lender have an option to claim or
(3) ‘Foreign Exchange’ Defi ned not to
Foreign exchange has been defi ned as the claim compensation, we have clear instances of
conversion of an facultative
amount of money or currency of one country into an compensation. (See Comment No. 6 {b-4} under Art.
equivalent 1278).]
amount of money or currency of another. (See Dr.
Edgardo C. (d) When one debt arises because of a claim for
Paras, Economics for Lawyers, 1993, pp. 594-603). support due
to gratuitous title.
Art. 1287. Compensation shall not be proper when [NOTE: Support in arrears may be compensated (Art.
one of 301, par. 2, Civil Code) but not future support, for
the debts arises from a depositum or from the this is
obligations of “vital to the life of the recipient.” (Report of the Code
a depository or of a bailee in commodatum. Commission).]
[NOTE: In the foregoing discussion, please observe
Neither can compensation be set up against a that while compensation cannot be made use of by
creditor one party
who has claim for support due by gratuitous title,
without (e.g., the depositary), compensation may be claimed
prejudice to the provisions of paragraph 2 of by the
Article 301. other party (e.g., the depository). This kind of
compensation,
(1) When Legal Compensation Cannot Take Place whereby only one side can claim it but not the other,
is referred to as FACULTATIVE
This Article speaks of the instances when legal COMPENSATION.]
compensation
2) Some Problems (e) The depositary cannot make use of the thing
(a) A has a P1,000,000 savings deposit with the Phil. deposited
National without the express permission of the depositor.
Bank. One day A borrowed P200,000 from the Bank. Otherwise,
Without he shall be liable for damages. However, when the
asking permission from A, the Bank subtracted the preservation of the thing requires its use, it must be
P200,000 from A’s account, leaving a balance of used
P800,000 but only for that purpose. (Art. 1977, id.).
in A’s favor. Is the bank’s action proper?
ANS.: Yes. Compensation is allowed here because in Art. 1288. Neither shall there be compensation if
this case, the relationship between the bank and the one of the
depositor debts consists in civil liability arising from a penal
is that of debtor and creditor. (See Art. 1980, Civil offense.
Code and Gullas v. Phil. Nat. Bank, 62 Phil. 519).
(b) A asked B to keep P1,000,000 for him. Now, A is (1) Non-Compensation if One Debt Arises from a
indebted to Crime
B for the amount of P400,000. When A asks for the
return Reason for the provision:
of his money, B gives him only P600,000, alleging “If one of the debts consist in civil liability arising
partial from a
compensation. Is B correct? penal offense, compensation would be improper and
ANS.: No, B is not correct because the P1,000,000 inadvisable
deposit with him is not subject to compensation. (Art. because the satisfaction of such obligation is
1287, imperative.” (Report
1st par., Civil Code). of the Code Commission, p. 134).
(3) Obligations of a Depositary (2) But Victim Can Claim Compensation
The law says that compensation is not proper when
one of It is clear that the criminal cannot claim
the debts arises from the obligations of a depositary. compensation.
Now, what How about the victim?
are some of these obligations of a depositary? ANS.: He should be allowed. Justice J.B.L. Reyes
says:
ANS.: “This should be specifi cally limited to the accused to
(a) The depositary is obliged to keep the thing safely prevent
and to his escaping liability by pleading prior credits against
return it, when required, to the depositor, or to his the offended
heirs party. But not to the victim of a crime who happens
and successors, or to the person who may have been to
designated be indebted to the accused.” (Observation on the new
in the contract. (Art. 1972, Civil Code). Civil Code,
Justice J.B.L. Reyes, Lawyer’s Journal, Jan. 31,
(b) Unless there is a stipulation to the contrary, the
1951).
depositary
cannot deposit the thing with a third person. (Art.
(This is again another instance of FACULTATIVE
1973,
id.). COMPENSATION.)

(c) If deposit with a third person is allowed, the Art. 1289. If a person should have against him
depositary is several
liable for the loss if he deposited the thing with a debts which are susceptible of compensation, the
person rules on
who is manifestly careless or unfi t. (Ibid.). the application of payments shall apply to the
(d) The depositary is responsible for the negligence order of the
of his compensation.
employees. (Ibid.).
Art. 1290. When all the requisites mentioned in
Article
1279 are present, compensation takes effect by
operation of
law, and extinguishes both debts to the concurrent
amount,
even though the creditors and debtors are not
aware of the
compensation.

Automatic Compensation if All Requisites Are


Present
(a) Note that legal compensation takes place
automatically
unless there has been valid waiver thereof.
(b) Compensation which extinguishes principal
obligations
also extinguishes accessory obligations. (Manresa).
(c) “To the concurrent amount” means that if one
debt is larger
than the other, the balance subsists as debt

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